Memorandum by the Association of British
Insurers (ABI) and the British Bankers Association (BBA)
1. Both the ABI and the BBA welcome the creation
of a single regulator for the financial services industry, and
believe it is important that good progress is made in underpinning
the FSA with a legal framework that will enable it to function
and adapt to changing circumstances. As such we endorse the framework
approach to legislation in the Bill.
2. A central theme in many of our comments is
a concern in the banking and insurance industries that a much
more formal system of supervision is being introduced, with a
heavy reliance on detailed rules backed by a discipline and enforcement
system for breaches of rules. Such an approach will tend to undermine
the collaborative and open relationship that has existed, particularly
with reference to prudential and control issues, which in the
past has encouraged a constructive approach to resolving issues
of concern as they arise.
3. The FSA will be accountable to Ministers
in the first instance and through them to Parliament. Various
additional mechanisms such as the FSA's Annual Report and the
work of the Treasury Select Committee will further strengthen
FSA accountability. In addition we believe the Treasury should
have a right to comment on whether rule changes are consistent
with the FSA's statutory objectives, and we also believe that
the rate of fees set by the FSA should be regarded as a rule change,
and therefore made subject to formal consultation.
4. The statutory objectives as proposed are
broadly right, and it would be a mistake to caveat them with exemptions
and exclusions. The only additional objective for which there
is a strong case deals with competition, and would oblige the
FSA to take international comparators into account. As advocated
below, we believe this would sharpen FSA focus and provide a point
of reference against which to judge its rules.
Discipline Enforcement and Market Abuse
5. Issues related to discipline, enforcement
and the Tribunal have been deeply felt by the industry. Although
changes have been proposed, further change will be necessary if
enforcement is to be fair and effective. A more neutral starting
point for enforcement is needed; a stronger recognition that it
will normally be inappropriate to discipline on prudential matters,
or for breaches of general principles. The market abuse proposals
must address the issue of intent and should be able to accept
that dealing which fully fulfils the requirements of the code
of market abuse should not be subject to fines.
6. The Mortgage Code delivers an effective alternative
to statutory conduct of business regulation, and managing the
latter would bring real additional costs for members, and for
the FSA. We believe the review of the Mortgage Code, currently
under way by HMT, should be concluded before decisions are taken
on mortgage regulation.
1. The British Bankers' Association and the
Association of British Insurers are the two largest trade associations
for the financial services industry, covering together all major
insurance, banking and financial services markets at both the
retail and wholesale levels. Between them, they represent 96 per
cent of insurance business written in the UK and 95 per cent of
banking business. Their members are active throughout the UK,
within the single European market, internationally in wholesale
markets, as well as through a retail presence in some countries.
2. The brief evidence given below supplements
the original submissions of the ABI & BBA, which the Joint
Committee has access to, and addresses the particular subjects
raised in the Joint Committee's Press Notice 2 of 10 March.
3. HM Government has chosen to establish a powerful
independent regulator on a statutory basis, covering a wide scope
of the financial services industry and most financial markets.
To fulfil its objectives the FSA needs considerable rule making
powers, and the capacity to enforce these in a manner which is
fair and reasonable. The ultimate accountability of the FSA is
to Parliament, which can amend its powers by primary legislation
and has the opportunity to review its work through such bodies
as the Treasury Select Committee. In addition the proposed Annual
Report will enable Parliament to debate the FSA's work in full.
At the same time, while the FSA must be given room to do its job,
and not face operational interference from government, it is right
that the general accountability of the FSA should not be delegated
4. The proposals on accountability in the draft
Bill as summarised in paragraph 3.2 of HM Treasury's Progress
Report are necessary. The proposals to enhance consultation in
paragraphs 3.6 ff. are broadly welcome, but do not go far enough.
Given the importance of this matter it needs to be addressed in
primary legislation. Without change, consultation, a key obligation
in a statutory system, will be more formal than real. We consider
As well as consulting on proposed
rule changes and publishing a statement of alterations as proposed
in paragraph 5.2 of the Progress Report, where FSA rejects widely
argued positions from practitioners and/or consumers it should
be obliged to make clear in full why it has done so.
The Bill already provides that the
FSA should give Treasury copies of any rules or standing guidance
that it makes. In addition, Treasury should have the right to
state whether or not they agree that any changes or additions
are in line with the FSA's statutory objectives.
5. While the statutory basis for the consumer
and practitioner panels is welcome, as is the establishment of
a market abuse panel, none of these are substitutes for effective
consultation with the industry and with its Trade Associations.
Indeed there is a danger that the FSA will come to rely unduly
on these Panels, with the danger of indifference to the industry
or consumers more generally, or worse the possibility that the
Panels will cease to provide an independent view.
6. The funding of the FSA, whatever mechanism
is settled on, will be by the financial services industry via
a specific and hypothecated tax. There is therefore a strong case
for practitioner involvement in decisions about the setting of
the tax rate, and means should be found to establish this in legislation.
The solution is to make the rate at which fees are charged, and
not just the funding mechanism, a rule change on which the FSA
should be obliged to consult. In general the industry seeks a
well-funded regulator paying salaries that will retain and motivate
the quality of staff it needs for a demanding and important role.
7. The thrust of the statutory objectives established
in the Bill (clauses 3-6) is right, and it would be a mistake
to undermine it by reference in the objectives to the circumstances
of any specialised group. Creating enabling legislation which
allows the FSA to adapt and amend rules in the face of new circumstances
is right, and a restrictive set of statutory objectives would
weaken that adaptive capability which is fundamental to regulatory
effectiveness in the 21st Century. However, given the
key importance of the objectives and the principles to which the
FSA should have regard in the performance of its functions, Parliament
will expect Ministers to be satisfied that the FSA is acting properlyafter
all the Rule Book will have the force of law. In delegating such
powers to the FSA, there should be accountability that the powers
are being exercised in a manner consistent with the statutory
8. The broad definition of consumer is right
for primary legislation and should enable the FSA to draw more
carefully the lines between retail and wholesale markets as these
develop and change over time. Equally this definition should enable
a line to be firmly drawn between transactions undertaken in a
personal rather than business capacity. Stressing the importance
of consumer protection in general, not merely depositor or policyholder
protection, is right, and given meaning by the explicit wording
that such a right by consumers to expect protection brings with
it a correlative duty to make informed decisions and take responsibility
for them (Clause 5.2(c)). Competition is most effective in providing
innovative and cost-efficient services when consumers make responsible
and rational decisions on the basis of clear and adequate information.
9. The FSA will have a general duty (Clause
2(3)(e) and (f)) to have regard to the international character
of the financial services industry and the need for competition
between authorised persons, but we believe this is not enough.
Specifically there is a strong case for an additional statutory
objective that requires the FSA to treat all firms operating in
the UK in a like manner to the fullest extent possible, and to
promote such competitive neutrality abroad. Her Majesty's Government's
argument (4.16 of the Progress Report) talks of their "pervasive
influence", but influence is not enougha statutory
objective would oblige the FSA to draft rule changes it could
defend as consistent with an international competitiveness objectivesomething
which needs to be established in legislation. In fulfilling this
general duty, FSA will need to have regard to the burden its supervisory
requirement places on regulated entities, compared to those placed
on competitors with equivalent business regulated elsewhere.
10. We have expressed our concerns about the
proposed disciplinary framework to the Government in our response
to the draft Bill and to the FSA in response to their Consultation
Paper on enforcing the new regime (CP17). Our concerns relate
to the fairness of the proposed arrangements, the interaction
of the enforcement regime with effective supervision, and compatibility
with the European Convention on Human Rights. Our comments here
take into account the revisions proposed by the Treasury in its
progress report dated March 1999.
11. At the outset it is worth stressing the
very considerable enforcement powers that exist at present, and
which will not be abolished with the passing of this legislation.
It is already the case that banking and insurance supervisors
can restrict the range of businesses our firms are involved in,
and that they apply capital and solvency rates well above those
required by EU legislation. These additional capital and solvency
charges cost our members very significant sums, and they are variable
by the regulators on the basis of their assessment of the performance
of our members in delivering on their regulatory obligations.
Powerful enforcement tools exist in the current arrangements,
and there is a case for reviewing whether or not they should be
retained in their current form, given the major new enforcement
tools that are to be introduced under the Bill.
12. Our concern with process of enforcement
proposed in the Bill relates to the need to ensure a separation
of enforcement into distinct steps, with independent parties involved
to ensure that a subsequent step is not tainted by an earlier
decision. The steps are
(i) investigation of an apparent breach of
rules or law;
(ii) decision to proceed against the relevant
(iii) decision to convict, fine or censure;
(iv) appeal from this last decision.
13. As proposed, the FSA is empowered to undertake
all the first three (except for a criminal offence, when step
(iii) will be for a court). The Bill will now require the FSA
to establish and publish procedures and to act in accordance with
such procedures. However, the FSA will have to work within the
Bill framework whereby step (ii) consists of a Warning Notice,
which is not just a decision that there is a case to answer but
that the person will be fined or censured unless they can prove
themselves innocent. This presumption of guilt is uniquely reserved
for financial services and does not exist in criminal law. The
process proposed is not commensurate with an open and constructive
relationship with regulated firms. We believe that the process
needs to have a more neutral starting point so that both sides
can be heard before any decision to take disciplinary action is
taken, even in principle. It is argued that, because the Tribunal
will rehear the whole case, the person involved is protected.
This ignores the reality of the costs involved in preparing and
presenting a case at such a Tribunal, which lead individuals to
settle when they should not. Indeed, the whole process needs to
incorporate the possibility of legal representation and the reimbursement
of costs by the FSA when they instigate proceedings which subsequently
14. Under the proposed legislation the FSA will
be given unique powers to levy unlimited fines for breaches of
its rules based on a civil rather than criminal burden of proof.
Further efforts must be made to clarify that where very large
and damaging fines are proposed, the burden of proof employed
should be criminal not civil. While it is accepted that financial
services companies deal in sums of money which may appear large
to the man in the street, it is nevertheless unfair that they
should be subject to arbitrarily large penalties, especially as
it appears to be the FSA's intention to assess fines as a deterrent
and our experience of SROs adopting a similar attitude is that
fines are escalated without regard to the real mischief being
penalised. For our members, the reputational damage caused by
the publicity surrounding any adverse finding by the regulator
is sufficient deterrent. It is even more invidious to increase
fines merely in order to increase the point size of the ensuing
press headlines. In general, the use of enforcement action should
not come to be viewed as a mark of success in regulation and it
is not an appropriate way to illustrate public accountability.
15. Banking and insurance firms have a need
for prudential supervision which is quite different from conduct
of business regulation. This supervision works best when the supervisor
and the institution develop mutual trust and understanding. We
are concerned that if, when a firm voluntarily discusses a particular
situation frankly with its supervisor, this results in enforcement
action, the climate of trust will break down and the supervisory
relationship will not function. The sanctions imposed when prudential
solvency requirements are breached should focus on corrective
action rather than retributionthe imposition of fines is
only appropriate in cases of deliberate or reckless misconduct.
16. There is a concern about privileged and
confidential information and documents which continues in the
financial services industry. The Government has stated its intention
to amend the proposed information gathering and investigation
powers of the FSA but it is not clear to us that they have met
our concerns. Prudential regulation can often involve the supervisor
seeking to assess how a regulated firm may be affected by particular
developments, for example when a bank's major customer is in difficulties
or an insurer receives many claims relating to a risk which has
changed in nature. In these situations, firms will wish to share
with their supervisor information which is confidential (because
it is part of the banker-customer relationship) or privileged
(because it has been prepared to assess the firm's legal position).
We have therefore two issues: first where financial institutions
hand over information or documents to the FSA, it must be clearly
established in law that such material always carries any legal
privilege with it. Otherwise financial firms will face uncertainty
as to where privilege stops, and be unable to co-operate fully
with the FSA.
17. Second there must be a clear set of rules,
underpinned by legislation, about onward disclosure of material
by the FSA to third parties, including overseas regulators. Different
legal systems or freedom of information requirements in other
countries may make disclosure inappropriate. An example would
be the disclosure of an insurers claims reserving policy being
treated as acceptance of liability, something which can cause
serious problems for firms. Disclosure to other regulators, subject
to Memoranda of Understanding, should require the FSA to obtain
assurance about the end use of any material disclosedproper
prudential purposes and the pursuit of financial crime are both
legitimate purposes, broader civil or political actions are not.
18. As we mention below under Market Abuse,
it is one requirement of the ECHR that an individual should know
what he is to comply with if he is at risk of a criminal sanction
for non-compliance. It seems to us only fair that a similar criterion
should apply for the sanctions at the FSA's disposal which, if
not criminal, are equally devastating in their effect on individuals
and firms. The Bill allows the FSA to make rules and evidential
provisions relating to those rules. The FSA is proceeding to make
very general rules ("Principles") and then more detailed
rules and codes of conduct which are evidential. This provides
a structure similar to that for Market Abuse where there is a
general offence and an evidential Code established by the FSA.
In both cases, the FSA reserves the right to take action on the
basis of a breach of the Principle or Clause 56 of the Bill, as
qualified by the Code of Market Abuse, even where no other rule
or code provision has been breached. We believe that this cannot
be fair and that the Bill should restrict the FSA's scope for
action to breaches of Rules only. It should be possible to rely
on compliance with an evidential code.
Rights of civil action in respect of breaches
of the rules
19. Further, the availability under the Bill
of direct rights of action for breaches of rules is unhelpful
and unnecessary. It is unhelpful in that it could lead to a legalistic
and cautious approach to the drafting of rules (a danger which
FSA recognise and feel they can overcome) and unnecessary given
rights of access to the Ombudsman or the courts.
20. The new regulatory regime should not incorporate
a civil right of action for breach of a rule. Perhaps more than
any other factor, Section 62 of the Financial Services Act, which
provides such a right, increased the pressure for detailed provisions,
rules and exemptions. There was a strong perception that without
plenty of detail and certainty, the rules would lead to dramatically
increased litigation. As the then Chairman of the SIB put it:
"[Section 62] had a serious
adverse effect on the SIB rulebook . . . the problem was that
it focused the attention of practitioners and more particularly
their lawyers on amending the rules not to improve them generally,
but simply to minimise the possibility of claims. This led to
long and complicated provisions, attempting to draw fine distinctions
to produce safe harbours for legitimate industry practice, whilst
maintaining the essence of the original objective of the rule".
21. If this proposal is retained, it should
be more clearly defined by amending Clause 80 (3) of the Bill
so that a particular rule would have to positively provide for
the right of action by a private personsomething which
may be more appropriate in specific cases, for example disputes
about fair dealing.
Mortgage advice and the regulation of loans secured
22. Although the Committee has said it will
be looking at the position of mortgage advice, it is not clear
to us that this can be viewed in isolation of the broader question
of the regulation of loans secured on land (to use the terminology
of Schedule 2 of the Bill). We consider it very important that
the regulatory regime under the Bill provides an appropriate level
of consumer protection, taking into account, inter alia,
the nature of the financial service in question and, where appropriate,
the existence of alternative means of regulation, such as industry
codes of conduct. The conduct of mortgage business is currently
governed by such a code of practice, the Mortgage Code. All significant
mortgage providers adhere to the Mortgage Code and, since last
year, mortgage intermediaries have also been covered by the Code.
We consider it to have been an effective alternative to statutory
regulation, and the changes to the compliance machinery for the
Code, currently in the pipeline, such as an enhanced monitoring
and disciplinary role for the Independent Review Body, will further
enhance its effectiveness.
23. We recognise that HM Treasury is currently
reviewing the efficacy of the Mortgage Code and will decide later
this year whether the regulation of loans secured on land should
be placed within the scope of FSA. Parliament will also wish to
take a view on the desirability of the regulation of mortgage
advice, and we would hope that the timing of this decision will
be such as to allow the outcome of the Treasury's review to be
taken into account.
Recognised Professional Bodies
24. The approach to RPBs as indicated in Section
3 of HM Treasury's "Regulated Activities" paper (February
1999) is right. Where legal and accounting professionals provide
investment advice in a manner which is subordinate to their main
services, they should not have to seek authorisation. Where they
provide financial services as free standing products, it is right
that they should have appropriate authorisation from the FSA and
be regulated on exactly the same basis as other authorised firms.
The Financial Services Ombudsman
25. Effective redress arrangements are essential
for consumer confidence in financial services. We support the
proposals for a single financial services Ombudsman (FSO) scheme
for the resolution of complaints which are not capable of being
resolved via a firm's own internal complaints procedure. It should
help clarify the redress arrangements in the eyes of consumers
and should ensure a consistency of standards of redress across
the range of financial services to be regulated by the FSA.
26. The existing Ombudsman arrangements available
to customers of banks and insurers have provided a fast, effective
means of impartial redress binding on the firm and at no cost
to the customer. This will continue to be the case under the new
FSO scheme, but other advantages of the existing industry Ombudsman
schemes will be lost, we fear. This is because a statutory Ombudsman
scheme will, inevitably, be more legalistic in its approach compared
to the existing voluntary arrangements and this will have a detrimental
effect compared to the relative openness and informality with
which firms currently deal with the banking and insurance Ombudsmen.
This will be a particular danger, if the FSA insists on sharing
information received by the FSO.
27. Whilst the new FSO will, as we have noted,
provide welcome rationalisation, there will still be anomalies.
For example, Treasury ministers recently announced their intention
to extend the compulsory scope of the FSO, in respect of FSA-authorised
firms, to certain financial services which are not covered by
the Financial Services and Markets Bill. For banks this will mean,
inter alia, that their non-mortgage lending business will
fall within the compulsory jurisdiction of the FSO. However, other
lenders, not authorised by FSA, will be under no obligation to
join the FSO scheme, but may be subject to the Ombudsman's voluntary
jurisdiction should they so wish.
28. An effective compensation scheme is fundamental
to the Government's proposals for the new single regulator. We
support the Government's aims of a single compensation scheme
with a single board and a harmonised administration function.
29. We also agree with proposals which FSA has
issued separately (in their consultation paper 5 of January 1998)
that there is a need to distinguish between the differing needs
of customers of deposit-takers, insurance companies and investment
firms. This can best be achieved by having three sub-schemes within
the single scheme. This differentiation is currently reflected
in the three existing schemes; namely, the Deposit Protection
Scheme (and its building society equivalent), the Investors Compensation
Scheme and the Policyholder Protection Scheme.
30. We support the FSA's proposal that there
should be no cross-subsidy between the sub-schemes and we would
stress, also, the need for the compensation scheme to be seen
to be independent of the FSA. Consistent with the statutory objectives
set out in the Financial Services and Markets Bill, it is, we
believe, fundamental that the FSA should not seek to remove all
risk from customers, and some element of co-insurance should be
31. There is a particular difficulty in the
delegation of powers to set the scope of the compensation schemes
and the bases for levies. Parliament may prefer that primary or
secondary legislation is the appropriate way to define the extent
to which the customers of solvent businesses should pay for the
losses of other consumers.
32. The ABI and BBA agree with the policy objective
behind Part VI of the draft Bill, namely to seek to ensure that
UK markets operate in an open, transparent and fair manner. That
said, the draft Bill gives rise to serious concerns under a number
of heads, and needs to be amended in order to ensure fairness
and certainty. Fairness and sufficient certainty are essential
if firms are to feel confident in operating in UK markets.
Definition of the Offence of Market AbuseIntent
33. We strongly believe that there should be
a test of intent in the manner in which the offence is drafted
in Section 56. The absence of such an objective test has two effects:
it means that persons may be unfairly pursued for the unintended
consequences of their actions; it also means that the definition
of the offence is defined in a highly subjective way. Agencies
with a similar role to the FSA in other jurisdictions have to
demonstrate intent or show recklessnessand the SEC has
shown that it can be done in many hundreds of cases.
34. In focusing on the effect of behaviour instead
of on intent, the definition of market abuse in the draft Bill
does not, as the Government concedes, give participants sufficient
certainty as to the application of the market abuse regime. The
Committee will be aware that, in the opinion of Lord Lester QC,
"the Market Abuse offences as defined in the draft Bill are
framed at such a high level of generality that they do not satisfy
Article 7(1) of the Convention [the European Convention of Human
Rights], which requires, in accordance with the principle of legal
certainty, that an offence must be clearly defined in law so that
a person may foresee the consequences of his or its actions."
Role and Status of the Code of Market Conduct
35. The Government argues that it is the Code
of Market Conduct drawn up under Section 57 by the FSA which is
to provide the certainty that the legislation will not. This raises
two objections. Firstly, as a matter of principle, as this part
of the Bill applies universally and not simply to firms regulated
by the FSA, it seems desirable that clarity should be delivered
in the legislation itself. Secondly, the evidential status of
the Code means that compliance with it is not conclusive, and
yet compliance really ought to provide a safe harbour for commercial
36. This is covered in a separate section. The
concerns about due process have added force in the context of
market abuse in that the FSA enforcement regime will be applied
to persons not subject to authorisation by the FSA.
Overlap and Layering within the Market Abuse Regime
37. While we understand that Government and
regulators are keen to see compliance which goes beyond "lip
service", it is important that there is an overall coherence
to the regime, and that the layering of similar but not identical
requirements is avoided. We are concerned that in several respects
the proposed regime is unnecessarily complex. For example:
The interaction of criminal, civil
and regulatory provisions causes concern about the complexity
of the overall regime which will emerge.
The general definition of market
abuse goes beyond the definitions of the criminal offence of insider
dealing in the Criminal Justice Act, and of market manipulation
in section 212 of the draft Bill, and does not recognise the defences
allowed in those circumstances.
38. Firms will have to consider whether behaviour
is criminal or not, as well as whether it complies with the Code.
Even if it meets these tests, Section 56 may still be breached.
Authorised firms will, moreover, have to consider their behaviour
against the FSA's rules and any exchange rules which might be
applicable. There are also variations in the way that the various
requirements are drafted when dealing with the same matter.
22 March 1999